Free Trade under Trump: How We Got Here, and Where It Might Lead

You can find the German version of this article here.

“America First” and Global Protectionism

Source: Public Domain

While trade enthusiasts may have initially rejoiced when Donald Trump, globally renowned businessman, entered the presidential race in June 2015, many were undoubtedly surprised by his critical rhetoric on free trade. With an agenda to pursue policy that puts “America First”, Trump promised on the campaign trail to reevaluate the state of every U.S. trade deal, in order to “identify every violation of trade agreements a foreign country is currently using to harm…the American worker.” The deals that drew the largest amount of censure from Trump were multilateral agreements, namely the North American Free Trade Agreement (NAFTA) and the Trans-Pacific Partnership Agreement (TPP). Since being elected, the words of Trump as a candidate have diverged from the actions of Trump as President in several key areas, making it difficult to predict what long-term trade policy from the new Administration might look like. On the one hand, NAFTA – “the worst trade deal in the history of the world” – continues to exist, with Trump acknowledging that terminating the deal outright would be a “shock to the system.” On the other, Trump made it a point to withdraw U.S. involvement from the Trans-Pacific Partnership on his first day in office, effectively killing the deal in its current form.

Trump’s harsh rhetoric on free trade, combined with a willingness to renegotiate some deals while terminating others outright, has generated uncertainty abroad, and by extension, has created uncertainty over the future of the free trading order that the United States helped to create. Vitriolic remarks targeting Germany and other allies over U.S. trade deficits are a sharp departure from the post-war urging made by the United States to convince other nations to bind themselves to a global economic order characterized by multilateral institutions and agreements.

Over the last seventy years, however, the economic order has undergone dramatic changes by introducing a variety of new players and seeking to adapt to truly global challenges, rather than the concerns of a few powerful nations. A series of economic and social crises over the last decade has fostered disconnect between cosmopolitan politicians who push for further integration, and their constituents who wish to be shielded from the global spillover effect. A majority of critics have placed the blame with globalization, which has resulted in populist and protectionist rhetoric around the world espoused by politicians such as Nigel Farage in Britain, Marine Le Pen in France, Rodrigo Duterte in the Philippines, and President Trump himself.

Motivations behind Trump’s Trade Policy

A consistent theme throughout both Trump’s campaign and his tenure in the White House has not been the failure of free trade itself, but the failure of the President’s predecessors to strike favorable trade deals for the United States. Therefore, it can be assumed that Trump does not necessarily want to cease free trade, but rather change the rules by which it is played, in order to more ostensibly favor the United States. Three major ways in which the Trump Administration seeks to alter the current free trading system are: by renegotiating and/or withdrawing from multilateral free trade agreements, eliminating trade deficits while maximizing surpluses, and instituting a border adjustment tax that would incentivize exports and penalize imports. While this strategy has been praised by those clamoring for a shake-up of the current trade order, namely Americans in industries who feel that they have been disadvantaged by free trade, it also raises several major questions: Will these protectionist measures provide comprehensive solutions for the so-called “losers” of globalization, particularly with regards to employment? If so, can they be feasibly implemented in the current economic and political climate? Finally, how will this affect the United States’ relationship with other nations, particularly its transatlantic allies who are among the staunchest supporters of the multilateral economic order?

Although Trump’s proposed policies have come as a shock to many, the protectionist sentiment they embody have been building in the United States for decades. According to the Bureau of Labor Statistics, as of January 2017, there are 6.9 million less workers in the manufacturing sector than there were in January 1980. With this comes the hard-to-ignore trend of companies from Budweiser to Seagate to Ford moving their operations overseas, often in search of tax loopholes and cheaper labor. And while free trade has led to more affordable and accessible goods by eliminating both tariff and non-tariff barriers to trade, it has also made Americans feel as though other global players are gaining an advantage through “unfair” trade, a term Trump has used repeatedly both on the campaign trail and in the Oval Office. The Trump campaign quickly picked up on this sentiment, and in many ways this became the foundation for his “America First” platform, despite the entrepreneurial success he has enjoyed as a result of the policies he seeks to reverse.

Pulling Back from Multilateralism

Source: Public Domain
Source: Public Domain

The Trump Administration has been forthright in its dissent of multilateral trade agreements, maintaining that bilateral agreements are the way to ensure better terms for the American worker. Therefore, U.S. trade policy may walk itself back from the multi-nation agreements that have come to increasingly define the existing order. This was the case with TPP and is still a possibility for NAFTA, as the deal prepares for trilateral negotiations. One notable exception to this trend is the interest of the Trump Administration in reviving talks of a U.S.-EU trade agreement, but even this decision came once it was made clear to President Trump by Chancellor Merkel that the United States may not negotiate with individual Member States, after the Administration expressed interest in a deal with Germany.

The reasoning behind the bilateral route is arguably that President Trump believes the U.S. can exercise greater leverage over a single trading partner, and avoid being overshadowed by dissenting coalitions in the multilateral forum. Since taking office, President Trump has expressed interest in deals with Japan, China, and Great Britain, the latter being significant as it transitions out of the European Union. A U.S.-China trade deal was signed in May 2017, which will allow American beef to once again flow into China, as well as natural gas, and opens the American market to Chinese cooked poultry products and increased financial access by Chinese firms. This deal marks the first major step forward for Trump’s trade policy, and while it deals only with a small subset of the issues besetting each country, it has staved off some concerns that the U.S. and China are careening towards a trade war. However, given this erratic patter of condemnation and cooperation, the United States may find that not every country is willing to commit bilaterally and will opt instead for the security of multilateralism, a sentiment Japan has expressed in talks to move forward with TPP without the United States.

Minimizing Trade Deficits, Maximizing Surpluses

This search for maximum trade advantage through one-to-one negotiations ties into a second major tenet of Trump’s trade policy: to decrease trade deficits. The four largest U.S. trade deficits are with China, Germany, Japan, and Mexico, with China outpacing the other three countries by nearly $241 billion. The Trump Administration has sought trade deals with the first three to increase exports, and is trying to control imports from the latter through NAFTA renegotiations. While the U.S. deficit has grown consistently since the late 70s, ballooning in the 21st century, not all trade deficits are created equal. The comparative advantage of each nation to produce what they specialize in will naturally lead to trade imbalances, as not all goods carry equal value, and some countries may have a greater demand for a product than others. Although the U.S. does run a consistent overall deficit, it also runs a surplus with individual countries, the top four being: the United Kingdom, Singapore, Brazil, and Hong Kong. And while the goods deficit is the major determinant of the overall deficit, the U.S. services sector has been steadily increasing since 1971, producing a $248 billion surplus in 2016. Therefore, while the Trump Administration may push for bilateral deals in order to gain an upper hand in market access for U.S. exports, it is important to note that deficits are not always an example of an economy’s failure. Ultimately, consumer spending and saving habits determine a deficit, which is often outside the realm of free trade agreements.

Border Adjustment Tax

One of the most discussed aspects of the Trump Administration’s trade strategy is the Border Adjustment Tax, which would change existing corporate income tax into a destination-based cash flow tax and lower the tax rate from 35% to 20%. While both approaches are considered “trade-neutral” in that they will not significantly alter the U.S. trade balance, the plan would help fulfill one of Trump’s biggest campaign promises: to keep American companies from moving overseas. The tax would exempt exports, and impose a tariff on imports in order to incentivize firms to keep production domestic, instead of importing cheaper goods from abroad or moving operations internationally and selling products back to the U.S. The border adjustment tax, if passed, is projected to generate an additional $1 trillion in revenue over the next ten years, but this estimate is predicated on the U.S. continuing to run a deficit. Should the U.S. begin to run a surplus, as Trump claims his policies will foster, the tax will lose revenue.

While the tax itself is similar to the Value Added Tax (VAT), a federal tax found in many countries outside the United States, the Border Adjustment Tax will allow companies to also deduct wages when calculating their taxable net income figure, which is not permitted under a typical VAT. The major hurdle for the Border Adjustment Tax would likely come not from the U.S. Congress, but from the World Trade Organization, whose members may challenge the tax as discriminating against foreign goods. This is where the issue of wage deduction comes most significantly into play, as U.S. firms may deduct domestic wages in determining their tax obligation, while foreign firms under the VAT may not, creating an unfair advantage. There are also implementation issues involved with the Border Adjustment Tax, namely ensuring that the tax credit given to exports is offset by the tax paid on imports, and certifying that all imports are subject to the tax.

However, it is unlikely that the border adjustment tax will even reach this stage, as President Trump has all but withdrawn his support for the plan, and though Speaker Paul Ryan and other top Republicans remain behind it, this is likely not enough to garner the requisite votes.

Globalization and Automation

Source: by Public Domain

Whether because of dumping, tax breaks, cheap labor, or none of the above, many Americans see U.S. competitive advantage shrinking, as China and other newly-developed economies increase their share of the market. Combined with the closure of 56,190 American factories in the first decade of the new millennium alone, or roughly 15 per day, and an overall trade deficit of $505 billion in 2016, it isn’t difficult to see why many Americans have designated globalization as the source of their problems. However, this is a misplaced source of anger. Though the United States has lost nearly 7 million jobs in the manufacturing sector since 1980, in the last 30 years there has been an 85% increase in real manufacturing output. The reason behind this figure is not jobs being stolen by foreign workers, but by machines. 87.8% of U.S. manufacturing job loss can be attributed to automation, a figure that is expected to rise as technology continues to advance.

Therefore, while the facets of the Trump trade policy discussed here may achieve other objectives of the Administration, they will not bring a significant percentage of jobs back to the manufacturing sector. In fact, given that the United States has gained roughly $2.1 trillion as a result of trade expansion from 1950-2016, with another projected $540 billion in growth by 2025, the American worker may stand to lose even more opportunities if the United States pulls away from global trade. In order to truly put “America first”, the solution is to focus on those who have been disadvantaged by trade and seek to more equitably distribute its gains, rather than limit opportunities for collective prosperity in the global market.

What to Expect

It is unsurprising that the man who co-authored “The Art of the Deal” is seeking to alter the way the United States negotiates in the international trading arena. What has been surprising for many across the Atlantic is how much support he has garnered from the American people for these endeavors. Whether or not free trade is primarily to blame for a loss in manufacturing jobs and decreased competitive advantage, the average American worker believes that it is. And as Donald Trump showed on the campaign trail, sometimes making people feel heard is more important than being right. It is difficult to determine what direction trade policy will take under Trump, given that many of the major trade measures proposed by the Administration haven’t left the discussion phases. Moves such as seeking to renegotiate, rather than terminate, NAFTA, and expressing interest in a new iteration of a U.S.-EU trade deal show promise for the future of multilateral trade in the United States.

However, this should not assuage protectionist fears. It is likely that the U.S. will continue attempting to implement higher trade barriers in its quest to reduce deficits, whether or not the Border Adjustment Tax is passed. Regardless, the resulting interim instability and uncertainty could have a long-term effect on the United States’ relationships with key transatlantic allies, who may now view it as an unreliable or contradictory partner and will look to take charge by utilizing their status as the world’s largest trading block. At the end of the day, trade is not a zero sum game. And if the Trump Administration is trying to “win” free trade by changing the rules, it may find itself sitting on the sidelines watching the other players score.

Courtney Flynn, Program Associate, Forum World Economic Order, Friedrich Naumann Foundation for Freedom